Real Estate Firms Flock To Industrial Amid E-Commerce Boom

Law360, Minneapolis (June 7, 2017, 11:24 AM EDT) --

U.S. and global investors are increasingly pouring their capital into industrial properties amid strong outlooks thanks to the growth of e-commerce, and lawyers are helping their clients sort through various entitlement, development and conversion issues that come into play with such deals.

As companies like offer two-hour shipping, the need for such facilities in or very close to urban cores is soaring, and that can present challenges when it comes to building in downtown areas, according to attorneys.

And while ground-up construction is one solution to the burgeoning need for more industrial space, some developers are also seeing opportunities to convert existing brick-and-mortar retail spaces to industrial.

"The conversion wave is going to be the next one to kind of resurrect some of the real estate assets and given them the most efficiency," said Andrew Raines of Raines Feldman LLP.

The trend toward developing and repurposing for industrial is playing out in and outside dozens of U.S. cities. Phoenix has been a major hub, as has Dallas, Raines said. And Los Angeles, particularly given its proximity to ports, has also seen a rise in industrial activity.

Firms like Prologis have been particularly active. And DRA Advisors has invested more than $1 billion in industrial properties thus far this year.

"Proximity to the customer is essential to the success of e-commerce which in turn is driving demand for facilities with modern technologies close to higher population centers," said Patrick Valentino of VLP Law Group LLP.

Such developments, though, come with various challenges.

Barry Katz of Arnstein & Lehr LLP said developers need to make sure they have adequate docks in order to allow for the needed speed of delivery, and also need to make sure there is adequate parking, the latter of which can be an issue if the property is in an urban core where space is at a premium.

And building in downtown cores can also present more complex environmental and zoning issues than developers might encounter in more rural areas.

"If you were looking for a facility in the city, you would be concerned with having as part of the due diligence ... making sure there are no environmental problems," Katz said. "If there is an environmental problem, the lawyer would deal with it."

Also, getting access to such properties is not always easy, particularly for smaller developers.

Valentino said some firms are looking to pick up industrial properties through large portfolio deals, although that requires either having the cash on hand or lining up financing.

"For investors looking to own and operate, barriers to entering the industrial real estate market may be steep. The bigger real estate players will seek large portfolios to enter the market as construction lags behind demand," Valentino said.

And there is also pressure on smaller e-commerce retailers to compete, and to get the space they need given that there's still a scarcity of available product in many markets, Katz said.

"That puts an enormous strain on anyone trying to compete," Katz said.

"Amazon, they have the footprint. They have the money and the background. Walmart's trying to compete with them. How do they get started to do that? How do they create their infrastructure ... to meet the competition? The competition has sort of set the bar: almost immediate delivery," he added.

The financing side, though, has been a bright spot for players in the space. Banks have been generally willing to lend, and it's also easier for developers to get financing if they have a strong-credit tenant lined up, Katz said.

"Financing is good. The banks are eager and enthusiastic. Industrial is seen to be a very good source for long-term leases that are with good-credit tenants," Raines said. "It can be easily repurposed."

Of course, developers also need to get entitlement at the local level in order to do such projects, which can be a lengthy process, although lawyers say municipalities are often amenable to such projects, since they are often located in suburban areas that aren't quite right for office, multifamily or retail.

Still, getting city approval to convert to a different use can add delays and costs to projects.

On the leasing side, many of the leases for such spaces are for 10 years, Raines said, although they can be longer. And many of the leases are triple net, meaning the tenant also pays taxes and insurances in addition to rent.

And developers are also finding that there's plenty of capital from overseas that's now willing to invest in industrial, which once was a hard sell to foreign investors but now more overseas investors have become familiar with U.S. e-commerce giants.

"It's becoming more familiar," Raines said, of industrial. "Typical foreign investment of late has been trophy office, multifamily. The beauty of this is it's less management intensive. ... There are fewer landlord headaches because its triple net."

While investors are at present pouring cash into the industrial sector seeing little signs that it will slow, there is still a looming question about policy in Washington.

Valentino said President Donald Trump's trade policy could have ripple effects on the industrial market in the U.S., particularly if his policy limits global trade.

"On the one hand, a promise to rebuild America’s infrastructure will drive demand for raw materials storage," Valentino said.

"On the other hand, President Trump’s proposed changes to global policy could potentially diminish the demand for industrial spaces if global trade is limited. Isolating export partners would greatly lessen industrial real estate demand," he said.

Still, that uncertainly isn't stopping investors at the moment, as there is a big push to either convert existing properties to industrial or build new product.

"Delay is unacceptable, driving the need up the development chain for more distribution centers closer to delivery points," Valentino said.

By Andrew McIntyre

--Editing by Rebecca Flanagan and Emily Kokoll.